While many investors focus on earnings, Validea CEO John Reese says that some of Wall Street’s best strategists prefer to use free cash flow when analyzing a company.
“Free cash can be crucial to a business. Just look at what happened to overleveraged, overextended companies during the financial crisis in 2008,” Reese writes on Seeking Alpha. “Businesses that had weak cash flows, or negative cash flows (that is, those that were burning through cash faster than they were making it), were left scrambling to pay bills and stay afloat when banks stopped the lending merry-go-round; those that were generating a lot of cash, on the other hand, had much-needed flexibility. Not only were they able to weather the storm — many were able to use their cash to make some great deals amid the crisis (just think of Buffett and Berkshire Hathaway).”
Reese talks about how two top strategists — Bruce Berkowitz and David Herro — use free cash flow yield as a key part of their stock-picking approaches. He also looks at a handful of high-free-cash-flow stocks that get approval from his Guru Strategies (each of which is based on the approach of a different investing great, including Warren Buffett and Benjamin Graham). Among them: Coinstar and Redbox parent Outerwall Inc.